Exotic options: Single- and Double-Barrier Options

[sle]

if you know how to price your options, have a decent volatility modelling, vanilla options is good enough to do the job

Not really, though. You can't replicate continuous barriers or any other path dependent products using vanillas.

Ps. In equity derivatives, flow exotics are hugely efficient and tightly priced. Usually, you'd get a bit of a shakedown on the unwind but most of these are short dated enough not to be concerned about it.

 

[sle]

Agreed. If I am bullish, why not agree upon a floor knock-out to save on the premium. I actually didn't think that anybody outside of a huge firm did the delta-neutral thing.

Thanks for the info earlier.

If you are buying a call, adding a down-and-out KO is not gonna save you much. What would reduce premium a fair bit is adding a continuous KO on the same side (e.g. Call up and out or put down and out).

 

[hhiusa]

If you are buying a call, adding a down-and-out KO is not gonna save you much. What would reduce premium a fair bit is adding a continuous KO on the same side (e.g. Call up and out or put down and out).

Basically, the call has a floor that it has to reach before coming into existence and ceiling that knocks it out.

 

[sle]

Basically, the call has a floor that it has to reach before coming into existence and ceiling that knocks it out.

Same logic applies - the value of lower barrier is pretty low and it's not going to cheapen the structure much.

 

[water7]

Not really, though. You can't replicate continuous barriers or any other path dependent products using vanillas.

Ps. In equity derivatives, flow exotics are hugely efficient and tightly priced. Usually, you'd get a bit of a shakedown on the unwind but most of these are short dated enough not to be concerned about it.

well why not? honestly i don't see a problem setting it up in OP's broker
(based on OP objectives)

however i do see possibility of not getting filled at a "decent projected limit price", whether it is a triggered entry / exit

so if i have to trade barrier options for some reason, then i don't mind paying extra cents to the dealers

--
ps: just wondering, who is the regular buyer of this products? what is their main purposes?

thanks

 

[Quiet1]

A lot of OTC exotics are used in structured products for retail buyers, at least in Europe. If you are a high net worth person, ie have an account at a private bank, almost certainly you will be offered bond-like high yield products whose payoff is contingent on whatever index etc not breaching certain lower levels. Because of the term (say 5 years) and the reliance on KO features the equity option part of the structure is OTC.

In Asia, especially HK, the market for light exotics traded directly by retail traders is, or was recently, very large and active.

 

[dumpdapump]

...and most wealthy (or not so wealthy) individuals lost spectacularly on such structures. Most law suits are still pending or in process 9 years after the financial crisis when many such products exploded in the face of those investors. There is a reason why even Asian family offices have caught on and hired professional portfolio and money manager to invest in much better risk-adjusted return assets. The demand on the retail side for such structures was high but has significantly dropped in the past couple years.

A lot of OTC exotics are used in structured products for retail buyers, at least in Europe. If you are a high net worth person, ie have an account at a private bank, almost certainly you will be offered bond-like high yield products whose payoff is contingent on whatever index etc not breaching certain lower levels. Because of the term (say 5 years) and the reliance on KO features the equity option part of the structure is OTC.

In Asia, especially HK, the market for light exotics traded directly by retail traders is, or was recently, very large and active.

 

[sle]

PWM light exo flow coming from HK is still there. It's all very similar structures (accumulators/decummlatots mostly), smartly selling volatility with directional view. Because of "other business for PWM" lots of these guys are able to get super-tight execution and are doing well on their trades most of the time.

Longer dated structured notes business has a very different customer base, not active and they gotten slammed multiple times.

 

[ironchef]

If you are buying a call, adding a down-and-out KO is not gonna save you much. What would reduce premium a fair bit is adding a continuous KO on the same side (e.g. Call up and out or put down and out).

Care to explain what you meant by adding a down and out KO? And what about a continuous KO?

Sorry I have to ask. Being an amateur, I like to understand your discussions but am clueless what you folks are talking about.

Thanks in advance.

 

[sle]

Care to explain what you meant by adding a down and out KO? And what about a continuous KO?.

So imagine you are buying a put on SPX that expires in September. The strike is let's say 2400, however if SPX ever touches 2000 the put knocks out. So that would be a continuous down and out barrier. As an alternative, you can make it such that put would only knock out if at expiration SPX is below 2000. So that would be a European or terminal barrier.

The idea is that adding such a barrier cheapens the structure a lot because you lose the option when it's most expensive. I.e. the put you bought is deep ITM and suddenly it disappears. Also, clearly, continuous barrier cheapens the structure more because it has more opportunities to trigger.

Sorry I have to ask. Being an amateur, I like to understand your discussions but am clueless what you folks are talking about.

Nothing to be sorry about. I am always glad to answer questions and explain stuff.